Sterling sinks against euro as rally loses momentum

Poll position: the pound has risen since general election day despite little support from the Bank of England

Sterling sank to a three-week low against the euro today amid signs the economic recovery in the UK is running out of steam.

The pound fell against the single currency and gave up gains against the US dollar after a monthly health check on British factories disappointed investors.

The sell-off came as Swiss bank UBS warned that spending cuts and tax rises outlined by Chancellor George Osborne will dampen growth further and told clients to sell the pound.

"Sterling is likely to weaken further once the UK Government's fiscal austerity programme starts," said UBS currency strategist Monsoor Mohi-uddin.The pound fell 0.79 cent against the euro to 1.2026, its lowest since August 11. It also gave up some of its gains against the US dollar, trading up 0.42 cent at $1.5389, having earlier been as high as $1.5418.

Sterling rose sharply after the coalition came to power on hopes it would slash record borrowing of £155 billion last year, a whopping 11% of gross domestic product.

Investors are now more concerned about the impact the cuts outlined by the Chancellor will have on growth.

The pound will get little support from the Bank of England, which looks set to leave interest rates at the all-time low of 0.5% for some time to come.

Simon Derrick, chief currency strategist at Bank of New York Mellon in London, said sterling could fall to 1.15 and $1.45 by the end of the year.

"Although we certainly applaud the UK government's determination to begin tackling the fiscal deficit, we are also only too aware of the impact it will have on the UK economy and the headwinds facing the pound," he said.

"We are going to see a slowdown in the economy. Interest rates are not going anywhere in the near future and as a result sterling is going to lose its shine."

Today's sell-off came after a survey by Markit and the Chartered Institute of Purchasing and Supply showed the pace of growth in the manufacturing sector slowed to a nine-month low last month.

The Purchasing Managers Index, where a score of over 50 represents expansion, fell from 56.9 in July to 54.3 in August, the lowest level since November last year and far weaker than expected in the City.

"The looming public sector spending cuts are keeping UK manufacturers on tenterhooks and slowing the pace of the recovery," said CIPS chief executive David Noble.